Common Stock

What is common stock?

Common stock (ordinary shares under US law; in German, Stammaktien) is the basic form of participation in US corporations. It conveys a vote and a share in profit and in the proceeds on a dissolution of the company (liquidation proceeds), but no preferential rights. On a sale or dissolution, common stock is served only after all creditors and the preferential rights of investors from the preferred stock have been satisfied. It therefore bears the highest risk, but participates in increases in value without an upper limit.

In US startups, founders, employees and early supporters hold common stock, and employee options refer to it. The term common shares is equivalent; in British law the term is ordinary shares. In German transactions, it appears in term sheets of international investors, in review documents (due diligence) and in comparative calculations. The German equivalent is the ordinary share (Stammaktie) in a stock corporation, and in a GmbH (German limited liability company) the share without preferential rights, called in practice a common share (Stammanteil). Whoever holds it receives the residual value, that is, the amount left after all senior claims have been served.

Common stock and common shares in the GmbH

The GmbH has share capital of at least EUR 25,000 (Section 5(1) of the German Limited Liability Companies Act, GmbHG), which is divided into shares with nominal amounts in whole euros (Section 5(2) GmbHG). Voting rights follow the nominal amount, one vote per euro (Section 47(2) GmbHG). Without a different rule in the articles of association, each share participates in profit and liquidation proceeds in proportion to its nominal amount. A share without special rights thus corresponds economically to common stock.

“Stammanteil” is not a statutory term. In financing practice, it refers to the shares of the founders and early shareholders, as distinct from the preferred shares of the investors. Legally, both are shares of the same company; the differences result solely from the articles of association and the shareholders' agreement. In a stock corporation, by contrast, the ordinary share is the statutory basic type from which the preferred share is distinguished.

Position of common stock in the distribution waterfall

On a company sale or liquidation, claims are served in a fixed order: first creditors and financial debt, then the investors' priority amounts (liquidation preferences), and last the common shares. Preferred shares with a non-participating preference take part in this last tier only if their share by shareholding ratio is higher than their priority amount. Preferred shares with a participating preference take part in addition to their priority. The calculation across all tiers is carried out by a waterfall analysis.

Formula: Proceeds per common share = (distributable proceeds − priority amounts claimed) ÷ number of shares participating in the residual proceeds

If the sum of the preferences exceeds the proceeds, nothing is allocated to the common shares. Between the priority amount and the conversion threshold of a non-participating preference, by contrast, every additional euro goes solely to the common shares. Above the conversion thresholds, each common share receives the same amount as a preferred share. In insolvency, common shares regularly come away empty-handed, because shareholders are considered only after all creditors, including subordinated shareholder loans.

Control, transferability and vesting

Voting rights

The rule that every euro carries one vote is not mandatory. The articles of association can provide for multiple voting rights or exclude the voting right of individual shares. After several funding rounds, founders often lose the majority; their influence then depends on approval reservations, nomination rights for an advisory board and voting agreements, for example in a pooling agreement. In the US market, share classes with multiple votes for founders also occur.

Transfer restrictions

Common shares in growth companies are rarely freely transferable. The articles of association often make assignment subject to the consent of the company or the shareholders' meeting (restriction on transfer, Vinkulierung, Section 15(5) GmbHG). The shareholders' agreement adds pre-emption rights, tag-along rights (tag-along) and, for founders, often a lock-up obligation. Every assignment requires notarial recording (Section 15(3) GmbHG). A sale of individual shares to third parties, for example as part of a funding round (secondary sale), therefore regularly requires the cooperation of the other shareholders.

Vesting of founder shares

In the US market, founders often hold their shares as restricted stock with a repurchase right of the company. In the GmbH, the commitment is made through reverse vesting: the founders undertake, on early departure, to transfer back a declining part of their common shares. The price for this follows the leaver rules of the shareholders' agreement.

Value of common shares and employee participation

At the same point in time, a common share is worth less than a preferred share, because it lacks the priority rights. In the US market, the value of common stock for the issue of employee options is determined by an independent valuation, which US tax law requires in Section 409A. It is regularly below the price of the last round. In Germany there is neither this procedure nor a fixed discount rate.

For tax purposes, the decisive value for real shares is the fair market value (gemeiner Wert), that is, the price that could be achieved on a sale in the ordinary course of business. For unlisted shares, Section 11(2) of the German Valuation Act (BewG) derives it primarily from sales between independent third parties less than one year ago. Whether the price of a funding round, paid for shares with preferential rights, can be transferred to common shares without a discount is a question of valuation in the individual case. For virtual shares the question arises differently: the participation plan (ESOP) generally ties the payout to the proceeds per common share on exit. It also sets the strike price itself, that is, the amount deducted from the proceeds per share.

Worked example: calculating proceeds per common share

A GmbH has share capital of EUR 50,000, divided into 50,000 shares of EUR 1 each. Founders and early shareholders hold 40,000 common shares (80%). An investor paid EUR 6 million for 10,000 preferred shares (20%), that is, EUR 600 per share, and holds a simple non-participating preference. The post-money valuation was thus EUR 30 million.

• Proceeds of EUR 15 million: The investor receives its priority of EUR 6 million, since its ratio would yield only EUR 3 million. EUR 9 million is allocated to the common shares, that is, per common share 9,000,000 / 40,000 = EUR 225. Per preferred share it is EUR 600.
• Proceeds of EUR 30 million: Priority and ratio each yield EUR 6 million. EUR 24 million is allocated to the common shares, EUR 600 per share, exactly the round price.
• Proceeds of EUR 60 million: The investor receives its ratio of EUR 12 million. EUR 48 million is allocated to the common shares, EUR 1,200 per share, as much as per preferred share.
• Employees with 100 virtual shares and a strike price of EUR 300 receive nothing at proceeds of EUR 15 million, because EUR 225 is below the strike price. At EUR 60 million they receive (EUR 1,200 minus EUR 300) × 100 = EUR 90,000 before tax.

The ratio between common share and preferred share is thus not a fixed ratio. At proceeds of EUR 15 million, the common share reaches 37.5% of the preferred share, and from EUR 30 million 100%. The payout to the virtual shares slightly reduces the distributable proceeds and is disregarded here for simplicity.

Distinctions: common stock, preferred stock and share capital

• Preferred stock: the preferred share class of investors under US law; in the GmbH, preferred shares with special rights.
• Share capital: the sum of the nominal amounts of all shares, whether with or without preferential rights. The balance sheet shows it as subscribed capital within equity (Section 272(1) of the German Commercial Code, Handelsgesetzbuch, HGB). US accounting keeps the equity account Common Stock for this, which stands on the credit side.
• Virtual shares: contractual payment claims that replicate the proceeds per common share, without voting rights and without shareholder status.
• Fully diluted: a view that includes, besides the common shares, all preferred shares, options and virtual shares.

Common mistakes

• Stock corporation law applied to the GmbH. Terms such as ordinary share or share class do not fit shares in a GmbH; what matters are the GmbHG, the articles of association and the shareholders' agreement.
• Paper value derived from the round valuation. Stake times post-money valuation does not give the value of the common shares as long as preferences exist.
• US valuation rules adopted. The US valuation procedure for common stock and flat discounts have no basis in Germany; the tax value follows the Valuation Act.
• Transfer restrictions overlooked. Restriction on transfer, pre-emption rights and lock-up obligations prevent founders from selling their common shares without the cooperation of the other shareholders.
• Strike price and proceeds per common share not reconciled. If the strike price of virtual shares is above the realistic proceeds per common share, the programme loses its retention effect.

Frequently asked questions

Is there common stock in Germany?

Not under this name. In a stock corporation, the ordinary share corresponds to it; in a GmbH, the share without preferential rights, which practice calls Stammanteil.

What is the difference between common stock and preferred stock?

Common stock has no priority rights and is served on exit only after creditors and preferred stock. Preferred stock receives its priority amount first and usually additional protective rights such as approval reservations and anti-dilution protection. With non-participating preferences, the amounts per share converge as soon as the proceeds exceed the conversion thresholds.

Can founders sell their common shares freely?

As a rule, no. The articles of association and the shareholders' agreement usually provide for consent requirements, pre-emption rights and tag-along rights, and the assignment must be notarially recorded.

Do common stock and common shares receive a dividend?

Only if the shareholders' meeting resolves a distribution. Growth companies generally reinvest profits, and distributions must not touch the assets needed to maintain the share capital (Section 30 GmbHG). Participation agreements also often make distributions subject to the investors' consent.

How is the sale of common shares taxed?

That depends on the size of the holding and the holding structure. If a privately held stake amounted to at least 1% at any time in the last five years, 60% of the gain is subject to income tax (Section 17 of the German Income Tax Act, EStG, partial income method). Below that, the flat-rate withholding tax of 25% applies. If a holding GmbH holds the shares, 95% of the gain remains tax-exempt under Section 8b of the German Corporation Tax Act (KStG).

The Roemer Capital view

We do not answer founders' question of what their shares are worth with stake times last valuation. Instead, we calculate the proceeds per common share at several realistic sale prices, after all preferences and employee programmes have been served. Only this figure shows what effect a further round with additional preferential rights has on the founders' position.

In a company sale and in succession, we examine the transfer rules for common shares early, because restriction on transfer, pre-emption rights and consents determine the timetable of a transaction. Notary and law firm handle the legal implementation; we coordinate the economic side.